When to pounce on a Brexit buying opportunity
There have been warnings that the U.K. is uninvestable, thanks to political uncertainty
Britain has become the outcast of global markets, untouchable for many as the country’s politics descends into chaos. This ought to create opportunities for those able to stomach the wild price swings as U.K. politicians abuse each other.
Investors face the usual two questions: Will bad stuff happen? And what probability is the market putting on it happening? Both are difficult to work out, but the bad stuff—a “hard” exit from the European Union with no transition period—is so bad it puts many investors off altogether.
There have been lots of warnings recently that the U.K. is uninvestable thanks to the political uncertainty and the volatility.
In my view, the chance of a hard Brexit is tiny. If it happens, the pound would crater and domestically-exposed London stocks would be crushed as investors flee economic disaster. But if there’s some “soft” Brexit compromise or the cancellation of Brexit altogether, sterling should rise and domestic stocks rebound as fear evaporates. While the details of the compromise matter a lot for the long term, for British politics and for Britons, for the next year’s trading all the market needs to hear is that there will be no hard Brexit.
Start with the bad stuff. A hard Brexit on March 29 is automatic if nothing else is done. Parliament is so divided that there’s no majority for any of the many possible compromises, one reason people are worried.
Yet there are few ways a hard Brexit could happen, and all seem implausible. Faced with a failure to agree on anything else, would Theresa May want to go down in history as the prime minister whose last act was to decimate industry and trade and force the stockpiling of food and medicine? She can unilaterally reverse course up to the last minute, so it is hard to believe she would go through with a catastrophic no-deal Brexit.
Mrs. May has a shaky grip on power and might not survive as prime minister until March. Opposition leader Jeremy Corbyn has no love for the EU, but he is against a hard Brexit, so if he took over after a snap election or ruling-party defections some softer solution would again be more likely.
A slightly more likely route to a hard Brexit is that Mrs. May once again rolls over her red lines and calls a second referendum—something she ruled out on Monday. Voters might go for a hard Brexit, bucking the polls just as they did in 2016.
But back then, voters were promised that a Brexit deal would be easy to secure, not that the country would run short of vital supplies. Voting for a softer Brexit seems much more likely.
Is the market pricing this risk correctly? Bets at bookmaker Smarkets put a 23% chance on a hard Brexit, which seems high. Political risk consulting firm Eurasia Group estimates a 10% chance of a hard Brexit.
“It’s one of those completely binary situations, that’s the problem with it,” says Nick Moakes, chief investment officer for the £26 billion ($32.77 billion U.S.) Wellcome Trust foundation. “We’re much better off looking for things elsewhere [in the world] where we have a clearer line of sight.”
“It’s difficult to see a no-deal Brexit but equally it’s difficult to see any other outcome.”
The market is putting a fairly small chance on a hard Brexit.
Currency options are skewed to a falling pound but aren’t showing as much concern as before the 2016 referendum, or the subsequent flash crash.
The pound itself has dropped toward the low end of its trading range against the euro since the 2016 referendum, but not made new lows. Sterling is down 12% against the dollar since its April high, but the fall was mostly about a rising dollar, not Brexit.
British assets are the mosthated globally, according to a Bank of America Merrill Lynch survey of fund managers last month. Yet, domestic-exposed U.K. stocks aren’t especially cheap compared with those with international revenue or compared with stocks in the eurozone.
There are cheap U.K.-exposed stocks—at the most extreme, housebuilders trade at 6.5 times next year’s estimated earnings. But there are plenty of cheap multinationals that won’t be much affected by Brexit, with U.K.-listed tobacco stocks at just 8.7 times forward earnings and oil and gas stocks below 10 times.
Brexit isn’t the only thing going on, either. Retail sales are sagging, painful for companies reliant on U.K. customers. And the threat that Mr. Corbyn will take power and force Britain to become a socialist paradise—or something—may be scaring investors as much as Brexit is.
Taken together, the markets aren’t as panicky about a hard Brexit as the headlines suggest, but still concerned enough to create some opportunities. Investors who share my view that a no-deal Brexit is highly unlikely might want to hold more sterling or buy some of the cheapest domestic-facing U.K. stocks. But the blundering ineptitude on show in Westminster might well create more intense concerns between now and March, and a better buying opportunity.